5/27/2002 @ 12:00AM

Shanghai Buzz

The city has emerged in the past ten years as the gateway to the most vibrant large economy in the world. This is why we consider it the most promising place for an entrepreneur. But investors better mind the potholes.

The American entrepreneur Cortney Smith arrived in Shanghai in 1996 to establish a bungee-jumping business. Chinese thrill-seekers latched on to it, and Bungee International now operates (or has sold the rights to operate) 16 Chinese sites for bungee-jumping and other extreme sports. He expects to add ten more sites this year, and revenue is predicted to total $1.6 million in 2002, up 33% from last year.

Smith believes that he chose a good place to set up shop. “People can feel a buzz in Shanghai,” he says. “It’s part of the sixth sense of entrepreneurs.” But sometimes there’s too much adrenalin. Like bungee-jumping, business in Shanghai can be exciting, but it certainly isn’t for the faint of heart.

This is not the first time that Shanghai is emerging as a top business center. A century and a half ago, the opening of China to international trade transformed the city into a capital of capital. Today Shanghai’s economy is growing even faster than China as a whole, and foreign investment continues to pour in. In the past ten years, the city absorbed $48 billion of foreign capital, nearly matching the amount nearby Taiwan has taken in the past five decades ($50 billion) and making it a top destination for foreign investment in China.

And foreigners alone aren’t the only ones who are rejuvenating Shanghai. Three of the five richest business families on FORBES GLOBAL’s 2001 China Rich List have their headquarters in Shanghai, including members of the Liu clan, which came out on top. Shanghai’s position at the mouth of the Yangtze River enables entrepreneurs to reach a market of 100 million, 13.2 milion in the city itself, and provides them with a central vantage point from which to penetrate the rest of China.

Even though Shanghai is in the vanguard of the economy, it can’t isolate itself from the rest of China. The nation ranks 25 out of 27 countries covered in our survey of tax misery this year. China stands far behind Hong Kong and Singapore in surveys of competitiveness; it’s hampered by a murky legal system and inadequate protection of intellectual property. Yet Shanghai is fast supplanting Hong Kong as the gateway to China. Despite Hong Kong’s adherence to British common law and its superb infrastructure, it is losing its preeminence for investors and entrepreneurs wanting to do business in China.

Shanghai has had to make up the ground that was lost in the early decades of communism. Successful entrepreneurs fled, and locals were taught to be ashamed of the city’s capitalist past. After 1949, people were usually not allowed to move to Shanghai from other parts of China, and most of the profits from city businesses were sent to the government in Beijing.

Things began to improve a decade ago. In the 1980s, southern China was the area that benefited from economic reforms. Then China began to unshackle Shanghai. It wouldn’t have happened as fast without help from top politicians in Beijing–the former mayors of Shanghai, Jiang Zemin and Zhu Rongji (today China’s president and premier).

Since 1990, Shanghai has been transformed. Blocks of prewar dwellings have been leveled and replaced with modern business towers and residential buildings; lavish spending has created a good road network. Foreigners and overseas Chinese have played a role in the renewal. Chinese families that fled communism have returned, joined by Taiwanese fleeing high costs at home and multinationals looking for cheap labor. Financial incentives have turned the city into the country’s hub for foreign banks.

Successful locals as well as top foreign executives once again dwell in elite neighborhoods, now made up of stand-alone homes that carry price tags in excess of $1 million. Major city streets are lined with restaurants and bars crowded with Chinese and foreigners alike. As prosperity has spread through central China, Shanghai has become a magnet for shops and is home to three of the country’s five biggest retailers.

Multinationals that are expanding in Shanghai include Microsoft, which, despite rampant software piracy in China, operates a global support center there; it’s tucked away behind a shopping district in the middle of the city. Technical questions from customers around the world arrive over the internet to the 400-person office. The staff figures out what the problems are and sends back replies (mostly prewritten).

“Shanghai has a great talent pool, in part because it’s a city where young people want to live,” says Jun Tang, the president of Microsoft China. In April the U.S. company announced a $4 million 50-50 joint venture with the government-owned Shanghai Alliance Investment to sell software. Other active Western companies include Intel, Alcatel and General Motors. Many big foreign companies say that the government has helped ease their way.

But small businesses face a tougher time. “It’s not really the little guy’s place yet,” says Mitchell Dudek, the partner in charge at the law firm Jones, Day, Reavis & Pogue in Shanghai, which advises large foreign companies on their China strategies. He does say that things are changing for the better. “It will happen over time.”

The challenges for entrepreneurs are many. Despite the buzz, Shanghai is still dominated by the public sector, and the government is a majority owner of its biggest local companies. About half of its gross domestic product in 2000 came from the government, compared with 40% for the country as a whole. State-owned banks rule the financial roost in Shanghai, too. And it’s sometimes hard for people from other parts of China to move there. “Shanghai before 1949 was a place where people came from all over China and the world to start businesses, and that helped make it great,” says Pamela Yatsko, author of a book on the city. “It needs to be a melting pot again, as New York is today.”

There are financial and administrative hurdles, too. For foreigners, it can cost hundreds of thousands of dollars to open a wholly owned business. Businesspeople complain about the difficulty in obtaining trading licenses and the high fees paid to government-sanctioned hiring agencies and middlemen. And although Shanghai is the city in China that is the most friendly to foreigners, it isn’t like Hong Kong or Singapore, where non-Chinese speakers can just show up and get things done. Traffic signs are in English, but most of the successful foreigners in the city speak Mandarin Chinese fluently. Many also have Chinese spouses to help them circumvent restrictions faced by foreigners.

Entrepreneurs are finding opportunities. In 2000, Jeff Bernstein, formerly a consultant at McKinsey, set up a logistics company in a special trade zone and provided warehousing and distribution services to companies that focus on finding customers and selling. Bernstein’s company had less than $5 million in revenue last year, and it is likely to double in 2002, encouraging him to look for venture capital. A cofounder of an organization for young entrepreneurs in Shanghai, he says that China should do more to ease the way for new businesses. “That China is such a hotbed of entrepreneurialism is in spite of the government’s policies,” he says.

Trade is also enabling Jeff Premer, a 32-year-old American, to realize his ambitions. He moved to Asia ten years ago and achieved success in Taiwan by selling locally made nuts and bolts. “It was a good business, and Taiwan had a lock on it,” says Premer, who speaks Mandarin fluently.

In November he moved to China, where his company, Diversitech Holdings, has found lower-cost suppliers in China; he expects its outsourcing business there to total $15 million, supplying tool kits and skateboard parts to such U.S. stores as Target and the Sports Authority. This is triple his revenue in Taiwan. He works through a representative office in Shanghai and channels sales through a trading company in Hong Kong.

Real estate is another source of wealth in Shanghai. Among the city’s most successful private entrepreneurs is Hui Wingmau; in our China Rich List last year we estimated his wealth at $723 million. Hui entered the property development business in Fujian province in 1989; he focused on Beijing in the early 1990s before turning to Shanghai at the end of the decade. “People go to Shanghai for business and to Beijing for politics,” he says.

Hui puts his money where his optimism is. Today the family has five projects in Shanghai worth well over $1 billion in total. Among the most notable: the Shanghai Riviera, seven buildings in the city’s Pudong district that vary in size from 47 stories to 60. He’s also building a hotel and commercial complex just north of the historic Bund area.

Foreigners are also becoming involved in Shanghai’s property market. Sam Crispin, a Briton who is managing director of FPDSavills’ office in the city, will leave the company in June to open his own property consultancy with a local partner. He arrived in Shanghai in 1994 and says that it is crucial to build up relationships with locals before starting a business. “I figured you could lose money on your own for eight years [by starting a business right away] or learn the ropes and then start out on your own,” he says. A new business needs a minimum start-up capital of $140,000, but this is less than half of what it was a few years ago, says Crispin: “The authorities now understand the benefit of small companies.”

More young Shanghainese who left to look for better jobs abroad are returning home in increasing numbers to start businesses. Jun Wu, 30, a former engineer with Sendit in Stockholm and with Microsoft, returned to Shanghai in 1999 to help form Intrinsic Technology, a wireless telecommunications software company that had revenue of $3 million last year. Investors today include Fidelity Investments and Taiwan’s Acer.

“Shanghai will definitely emerge as a technology center in Asia,” says Wu. “There are already more entrepreneurs, but we lack a world-class [high-tech] company for now. As soon as that happens, things will be seen differently.”

Encouraged by the prospect of financial reform, financial consultants have been arriving in large numbers. Stephen Harner, 52, formerly a vice president at Citibank in Japan and Taiwan and a former chief representative for Deutsche Bank in Shanghai, left the German company in 1999 to focus on his own financial industry and investment advisory firm. It wasn’t easy getting started. The initial capital requirement was $350,000, and it seemed that the office could be located only in Pudong.

It took him a few months to find a cheaper location while adhering to the regulations that stipulate where foreign-owned consultancies can be established. Harner, a fluent speaker of Mandarin, resides in Shanghai but does business through his Jiangsu entity.

Business has improved recently, he says, and he’s receiving work from the International Finance Corp., an affiliate of the World Bank, providing management advice to Chinese banks. He has also worked with foreign banks and insurers that are looking for ways to crack the China market. “Shanghai has been a good place to be because it is where foreign financial service companies are planning expansion.”

Shanghai’s progress could be knocked off course by China’s secretive domestic politics. The departure of the popular mayor Xu Kuandi for murky reasons in December is an example. China’s volatile nationalism can cause problems for foreign companies. Labor unrest is growing.

But Shanghai is on the right track. Two forces will help entrepreneurs. If China’s economy slows down, this may force the city to improve the investment climate by reducing red tape. China’s being a member of the wto is likely to improve the way private domestic companies are treated. “The reforms have been working so far in starting to move people out of the state companies and toward private ones [in Shanghai],” says Wong Siu-lun, head of the Center of Asia Studies at Hong Kong University.

What’s needed, he says, is for the government to reduce institutional barriers, such as access to capital. “The potential is there [for private companies to play a much bigger role],” Wong says. If this happens, Shanghai will become even more important for China and the world.